Deflation at work…

“Nearly 35 years after taxpayers spent $55.7 million building the Pontiac Silverdome and a year after a $20 million sale fell through, city officials have sold the arena once called the most desirable property in Oakland County. […] The price: $583,000. […] We had hoped it would have brought more, but now the city can be freed of its upkeep and get it back on the tax rolls,”

This is what deflation does. It reduces nominal wealth thus it reduces overall revenue streams and so it reduces tax revenue. As nominal wealth declines, entities can no longer expand outstanding debt due to diminished collateral. As revenue declines, entities can no longer expand debt and/or service existing debt and must lay off workers. As tax revenue falls, local governments have to lay off and curtail public spending.

Allowing banks to disregard mark-to-market accounting rules aims to avoid just this type of situation in the hope to buy time.

But inflation has a limit. If that were not the case, then you would expect some degree of direct correlation between inflation and GDP progression. But that is not the case. Since 1980 government and household debt expanded by 1200% to $26Trillion but GDP only expanded by 100% to $14Trillion. Thus inflation conforms to the law of diminishing returns.

From the inception of the modern Dollar in 1913 inflation proved to be a barrier almost immediately in 1929. Subsequently, by declaring convertibility to gold but not allowing anyone to check the quantities of the metal in storage, the USA were free to pretty much print whatever amount of money they wanted. Till the late 60s when the situation was fairly similar to where we are today.

By the early 70s it was decided to abrogate the monetary agreement that had been in force since WWII in favor of floating exchange rates meaning that now Europe too was on a fiat monetary system. Thus inflation could now be pushed into the new vacuum of the European markets. Then came globalization effectively allowing us to push inflation into the last remaining markets and the Euro that allowed us to inject a further dose of inflation in Euroland. Thus till very recently, inflation could come to the rescue of governments by decreasing nominal debt outstanding.

There are no more markets of any consequence that we can bring in on the inflationary gig. Thus my contention that we’ve reached the end of the inflationary cycle.

Industrial capacity and debt obligations are at historic highs. Interest rates, savings and capacity utilisation are at historic lows.

Why would gargantuan spending by governments to add even more industrial and commercial capacity solve anything?

Incidentally. Gargantuan government spending guarantees prolonged deflation because increased taxes will erode spending, hiring and investment. Therefore, if anything, spending of this magnitude only serves to delay the eventual recovery.

So, buying time may be a viable strategy if and when inflation has room to run. I think inflation can no longer be expanded at this point and that a gradual contraction in prices, wages and asset values is with us for some years to come.

The trouble is that the existence of government if predicated on inflation. No inflation = the bankruptcy of government.